It takes much engineering and design to be able to model a person or family’s financial life, with all of its complexities, ambitions, changing priorities–and still be able to make it simple, intuitive and actionable for each of our customers.
How We Use Data to Model and Optimize Your Financial Life
Personal Capital’s Retirement Planner was our first step towards a data-driven financial app that models your financial life and finds ways to improve it based on your aspirations and long-term goals.
This month we released two significant improvements to how we try to model and optimize your financial life by:
- Personalizing the model to save for and grow your portfolio, according to your specific tax situation, while you are saving for your retirement; and
- Personalizing the model to a tax-efficient withdrawal strategy for your retirement.
There were three main drivers as to why we focused on bringing you peace of mind and clarity on knowing where your income is coming from during retirement – and how much your portfolio, Social Security, and, most importantly, your taxes, will play into it.
As Craig Birk, our Chief Investment Officer, always says: a significant source of stress for many us is the question of what my income will be when I retire. Most of us are accustomed to a steady income, typically through our employment, so it might be hard to imagine life without it. Equally important is what the picture looks like if we run out of money.
In addition, most of us are also accustomed to working and paying a high level of taxes on our income. This is why many people overestimate their tax liability during retirement. The good news is, there is an answer to this question. Multiple studies (for example you can read this study or this article) show a good withdrawal strategy can help your money last multiple years longer. This is where tools like Smart Withdrawal™ can help. Smart Withdrawal is a new feature of the Retirement Planner tool and is available exclusively to Personal Capital Advisory Service clients. To learn more, contact a financial advisor.
Smart Withdrawal taps into your stream of financial data to further improve our ability to model your financial life to:
- Project your potential retirement monthly income
- Provide itemized income and spending goals and their source
- Apply the right withdrawal strategies for you to maximize your financial sustainability
So, we can give you clarity and confidence around your retirement years and help you achieve your financial goals.
However, let me take a big step back and tell you how we try to model a person or family’s financial life with these capabilities.
Steps to Modeling Your Financial Life to Enable Smart Withdrawal
- Gather Fragmented Financial Data into One Comprehensive Picture: The first step is to create a holistic view of your net worth by pulling all of your assets and liabilities–from investment and mortgage accounts, to the value of your home and options in a startup company. This is the richest raw financial data set that one can have about your financial life and it’s the basis of our financial model.
- Annotate the Raw Data: We then enrich the model by creating classifiers that annotate and augment your financial data, adding more depth, quality, and accuracy. Each transaction is categorized; the type of each financial account is determined; each security is identified, valued and classified; accounts are marked as taxable vs. non-taxable, portable vs. non-portable, actively traded vs. advised accounts; and hundreds of more attributes are added on each account, transaction, or holding.
- Detect Financial Behaviors and Patterns: We then try to extract facts about typical financial behaviors: earnings and savings per year, 401k/529 contributions, debt payments, luxury expenses, saving habits, pension, and Social Security incomes.
- Add Context to the Data: Next, we provide a wide-angle view and context for your data by comparing it to the market and cohorts. We compare your investment account performance to indexes, and compare your spending, savings, and 401k contributions to your cohort based on age, industry, and risk tolerance.
- Don’t Forget the Emotional Aspect of Money: It’s easy to let the analytical and quantitative part of your money take over how we model your financial life, but the truth is, money is emotional! This is why we have added an easy way for you to add your hopes and aspirations as “goals” and “events.” For me, after we put the kids to bed, my wife and I sometimes sit around the kitchen table and bring up Personal Capital’s Retirement Planner and dream: what if we bought a vacation home? What if we took a year off and traveled the world? Or what if we paid for our kids’ college? You can enter each goal and see its impact on the model and your financial life. Moreover, you may also be able to schedule a call with one of our financial advisors if you have questions or need further clarification.
- Personalize Your Tax Situation: As your wealth grows, so does the complexity of your finances – namely your tax situation. An essential component of modeling your financial life is to personalize it to your particular tax situation. Our approach is to annotate and group accounts based on their tax type: tax-free, tax-deferred, taxable, and education-related. Then we model how each group grows, and show how you should save into each group, as well as when the best time is to withdraw from each group.
- Determine a Personalized Portfolio Growth Strategy: Our algorithm is designed to balance your “need,” “ability,” and “willingness” to take risks. By default, the primary goal of the model is to maximize your portfolio’s odds of meeting your financial goals. We do this by finding the best asset allocation of funds that optimize your growth rate and withdrawal rate.
- Each Year of Your Life is an Equation for the Model: I asked Song Guo, our star engineer that architected many parts of this model, what was the biggest challenge in modeling a person’s financial life? His answer was this: Managing the complications of different growth and tax strategies for different money types and then apply a personalized optimization on top of it.Each year is an equation with many variables that we need to solve. Our solution was to create a flexible data structure that can adapt to your particular situation. Once we have a flexible data structure in place, we can then slice and dice your portfolio, savings, and spending in a way that optimizes your chance of meeting all of their goals.
- Project Different Scenarios of Your Financial Life: Life is full of adventures and crossroads and using our tools, you can model the financial impact of each of those adventures and decisions as a separate scenario and compare them against each other.
- Intuitive Data Presentation: A great data-driven application can take in a significant amount of intricate and detailed financial information and distill them to a comprehensible UI that makes the data accessible to you. A financial model is not just a series of calculations, but it’s an interactive application that allows you to visualize it, explore alternative what-if scenarios, and manipulate the financial data and model assumptions intuitively to personalize it further. I recommend that you read our great UI engineer, Jeff Carey’s, post on this.
- Keep it Evergreen: Because we model your financial life on top of a dynamic stream of data from the different financial institutions that you work with, this model changes with the significant changes in your life and the market. The model tries to morph with every turn of the adventure that is life. We have added built-in notifications to engage you when, say, your new spending pattern is different enough that you no longer can support your goals.
There is a natural flow to these steps, and if you try to visualize them, you can end up with a sequence like what you see here:
If you appreciate the challenges of modeling a person’s financial life, please check out our careers page!
To learn more about Smart Withdrawal, contact a financial advisor.